First U.S. Bank Regulations May Look Strikingly Familiar

A $2 United States Note, 1862.
Source: Bebee Collection of the American Numismatic Association

Feb. 25 (Bloomberg) -- One hundred fifty years ago, the
U.S. was two years into a brutal Civil War. The financial cost
left the federal government under enormous stress, leading to a
result no one had imagined: the first modern system of bank
regulation.

Before Congress passed An Act to Provide a National
Currency on Feb. 25, 1863, government oversight of banking had
been quite crude. The Second Bank of the United States,
chartered by Congress in 1816 and 20 percent owned by the
federal government, functioned in some ways like a central bank.
At the time, there was no national currency, and most banks
issued notes that were accepted as money.

In principle, those notes were redeemable for specie --
gold or silver coin -- but a merchant who accepted a banknote
from a customer had no way to know whether the issuing bank
would make good on its promise to pay. Many notes found their
way to the Second Bank of the United States, which returned them
quickly to the issuers with a demand for specie. The threat that
such tactics could put a bank out of business encouraged bankers
to manage conservatively.

After one of the most famous political battles in American
history, Congress, at the behest of President Andrew Jackson,
let the Second Bank’s charter expire in 1836. All responsibility
for banking passed to the states. Many states made it easy to
start a bank, imposing few requirements and exercising little
supervision. Having banks in every town issuing notes seemed an
effective way to stimulate local economies, and if a large
number of them failed, well, that was a price many governors and
legislatures were willing to pay in return for economic growth.

Greenbacks Proliferate

Faced with nearly endless needs for cash during the Civil
War, Congress decided it was time for a national currency, but
it lacked the gold and silver to support one. In 1862, it
authorized a government-issued paper currency with no promise to
redeem the bills for specie. Those bills, popularly known as
“greenbacks,” were declared to be legal tender for most
purposes. But the greenbacks circulated alongside notes issued
by private banks. Most people thought the private banknotes were
sounder, and were reluctant to take greenbacks except at a
discount.

The purpose of the Act to Provide a National Currency was
to replace this jumble of bills of uncertain value with a single
national currency. The law created a Currency Bureau in the
Treasury Department, headed by a comptroller of the currency.
The comptroller’s job was to charter national banks that would
issue U.S. currency. To do that, he needed to ensure the
national banks were sound.

The law’s language may seem archaic, but its approach to
regulation was surprisingly modern. It set what we would now
call capital requirements: The organizers of a national bank had
to put up $50,000, or $100,000 in a city with a population of
more than 10,000. It set reserve requirements: Each national
bank had to deposit bonds with the Treasury equal to at least
one-third of its capital. There were liquidity requirements: A
national bank was required to keep on hand “lawful money” equal
to at least 25 percent of outstanding banknotes and deposits.
And there were disclosure requirements, too: At the start of
every quarter, each national bank had to give the comptroller a
“true statement of its condition” with data on loans,
overdrafts, insider lending, real-estate ownership and other
matters.

New Rules

The law also imposed some novel rules on how bankers did
their business. It set limits on how much a national bank could
lend to any individual or company. It prohibited banks from
dipping into their capital to pay dividends to shareholders. It
required bankers to recognize loans on which interest was six
months past due as a bad debt, the first regulatory intervention
into bank accounting. To make sure things were on the up and up,
the comptroller was to appoint an examiner to visit each
national bank and “make a full and detailed report” of its
condition. If a national bank failed to make good on its notes,
the comptroller had the power to close it and pay off its
creditors.

All this may sound familiar. Many of the regulatory
concepts put in place in 1863 are still with us today. But in
one important way, the nation’s earliest bank regulations were
stricter than today’s. Congress made national bank shareholders
doubly liable -- if a national bank became unable to repay
depositors or other creditors, its shareholders could be forced
to ante up the par value of their shares, in addition to the
amount they had already invested. Double liability proved a
recipe for keeping banks sound. It was discontinued in the
1930s, but the comptroller’s examiners are still paying visits
to national banks today.

(Marc Levinson’s books include “The Great A&P and the
Struggle for Small Business in America.” The opinions expressed
are his own.)